Interest Rate Risk: How Rising Rates Hurt Bonds and Stocks

When the Federal Reserve hikes interest rates, it doesn’t just change your mortgage payment-it shakes the value of everything you own in bonds and stocks. This isn’t theoretical. In 2022, the Bloomberg Aggregate Bond Index lost 13%-its worst year ever. Meanwhile, tech stocks dropped 30% or more, not because companies failed, but because higher rates made their future earnings worth less today. If you hold bonds or stocks, you’re exposed to interest rate risk. And if you don’t understand how it works, you’re flying blind.

Why Bonds Lose Value When Rates Rise

Imagine you bought a 10-year bond paying 3% interest. Two years later, new bonds are offering 5%. Why would anyone buy your 3% bond when they can get 5% elsewhere? The answer: they won’t-unless you sell it at a discount. That’s the core of interest rate risk: bond prices fall when interest rates rise. It’s simple math. Your bond’s fixed payments become less valuable compared to new, higher-yielding options.

The bigger the bond’s term, the worse the hit. A 30-year Treasury bond might drop 25-30% if rates jump from 2% to 5%. A 2-year note? Maybe 4-5%. Why? Because long-term bonds lock you in for decades. The longer your money’s tied up, the more time there is for rates to move against you.

This isn’t guesswork. Financial professionals measure this sensitivity using something called duration. A bond with a 5-year duration loses about 5% of its value for every 1% increase in rates. That’s not a rule of thumb-it’s a precise calculation used by banks, pension funds, and mutual funds to manage risk. If you own a bond fund with a 7-year average duration, a 1% rate hike could wipe out 7% of your investment overnight.

Yield Curve Inversions and What They Mean

Interest rate risk doesn’t just move in one direction. Sometimes, short-term rates climb faster than long-term ones. That’s what happened in 2022-2023: the 2-year Treasury yield jumped above the 10-year yield. This is called an inverted yield curve-and it’s one of the most reliable recession predictors in finance. Since 1960, it’s preceded seven of the last eight U.S. recessions.

Why does this matter to you? When the yield curve inverts, it signals that investors expect slower growth ahead. They’re willing to lock in long-term rates now because they think rates will fall later. But for bond investors, it also means the market is pricing in a sharp slowdown. That’s bad news for corporate earnings and, by extension, stock prices.

How Rising Rates Crush Stock Valuations

Stocks don’t pay fixed coupons like bonds. So why do they care about interest rates? Because of the math behind how we value them.

Investors price stocks based on the present value of their future earnings. The higher the interest rate, the more you discount those future dollars. A 1% rise in the risk-free rate (like the 10-year Treasury yield) can reduce the present value of a company’s 10-year cash flows by 8-10%. For a tech firm that expects most of its profits to come in 7-10 years, that’s devastating.

Take Apple or Microsoft. They make money today, but their biggest value comes from products they’ll sell in 2030. When rates rise, those future profits get discounted harder. That’s why growth stocks-especially tech and biotech-get hammered first during rate hikes. Value stocks, which earn cash now, hold up better.

The numbers don’t lie. During the 2022-2023 rate surge, companies with interest coverage ratios below 2.0 (meaning they earned less than twice what they paid in interest) saw their stock prices fall 35% on average. The S&P 500? Down 19%. The difference? Leverage. High debt + high rates = financial stress.

Which Sectors Win and Lose

Not all stocks react the same. Some even benefit.

Banks and insurers often do well when rates rise-up to a point. They borrow short-term (at lower rates) and lend long-term (at higher rates). Their net interest margin widens. JPMorgan and Bank of America saw profits climb in 2022 as their lending spreads grew.

But other sectors get crushed. Real estate investment trusts (REITs) are a classic example. They rely on cheap debt to buy property. When rates rise, their borrowing costs spike, and their dividends look less attractive compared to bonds. In 2022, REITs fell 28% while the S&P 500 dropped 19%.

Utilities are another loser. They’re slow-growing, capital-heavy businesses. Investors buy them for steady dividends. When bonds offer 5%, a 3% utility dividend doesn’t look so great anymore. Same goes for consumer staples and other defensive stocks that trade like bonds.

How to Protect Your Portfolio

You can’t stop interest rates from moving. But you can reduce your exposure.

• Shorten your bond duration. Instead of holding 10- or 30-year Treasuries, go for 1- to 5-year bonds. They’re less sensitive to rate changes.
• Ladder your bonds. Buy bonds that mature in 1, 2, 3, 4, and 5 years. As each one matures, reinvest at whatever the current rate is. In 2022, investors who used this strategy lost only 8% compared to 15% for those holding long-term bonds.
• Switch to floating-rate bonds. These adjust their coupon payments as rates change. No surprise drops. Look for bank loans or floating-rate ETFs like FLOT.
• Hold cash or short-term CDs. Right now, you can get 5% on a 1-year CD with zero risk. That’s better than a 3% bond that might lose value.
• Focus on low-debt, cash-rich companies. Avoid firms with interest coverage ratios under 3.0. Look for companies that generate more cash than they spend on debt.

What’s Coming Next

The Fed raised rates from 0.25% to 5.5% between early 2022 and mid-2023-the fastest hike in 40 years. Now, they’re saying rates will stay high through 2025. That means the pain isn’t over.

Commercial real estate is next in line. Over $1.5 trillion in office and retail loans come due by 2027. Most were locked in at 3-4%. Now, new loans cost 7-8%. Many properties won’t make enough rent to cover payments. Defaults are coming.

Academics like Johannes Stroebel at NYU Stern found that stocks have become 40% more sensitive to interest rates since 1990. Why? Because companies rely more on future growth, and financial markets are more interconnected. The world isn’t the same as it was 20 years ago.

Bottom Line

Interest rate risk isn’t something you ignore. It’s the silent killer of portfolios. Bonds lose value. Stocks get discounted. Sectors collapse. And if you’re holding long-term bonds or high-debt stocks, you’re already losing money-even if you don’t see it yet.

The fix isn’t complex. Shorten maturities. Cut debt exposure. Diversify away from rate-sensitive sectors. And don’t chase yield in a high-rate world. Cash isn’t sexy-but right now, it’s the safest asset you own.